Banks to Suffer Big Decline in Mortgage Revenue in 2013

NEW YORK ( TheStreet) -- Regional banks enjoyed a blowout 2012 for mortgage revenue. But that may all come to an end this year.

That means investors can no longer count on a steady stream of glowing earnings-season headlines for mortgage growth or upward earnings-estimate revisions.

President Obama early last year expanded the Home Affordable Refinance Program, or HARP, to allow qualified borrowers with mortgage loans held by Fannie Mae ( FNMA) or Freddie Mac ( FMCC) to refinance at record-low interest rates, no matter how much the market value of the underlying home had declined.

The expanded HARP, along with record-low interest rates, led to a 39% year-over-year increase in U.S. mortgage loan origination volume to $1.75 trillion during 2012, according to the Mortgage Bankers Association (MBA). The low-rate environment also generated unusually high gains on the sale of newly originated loans to government-sponsored enterprises, including Fannie Mae and Freddie Mac.

Many of the large regional mortgage lenders saw continual increases in mortgage lending volume and profit last year, but gain-on-sale margins were already beginning to soften during the fourth quarter.

Projecting Declines in Margins and Volume

The Federal Reserve has kept the short-term federal funds rate in a record-low range of between zero and 0.25% since late 2008, and the Federal Open Market Committee has said this "highly accommodative" policy is likely to continue until the U.S. unemployment rate declines to 6.5%. But investors are always looking ahead, and the market yield for 10-year U.S. Treasury bonds has increased by 42 basis points over the past three months to around 2%.

Atlantic Equities analyst Richard Staite said in a Jan. 29 report that a concurrent increase in yields on mortgage-backed securities (MBS) led to a contraction in the primary secondary mortgage spread to 82 basis points from an average of 123 during the fourth quarter.

Jefferies analyst Ken Usdin said in a report Friday that the median gain-on-sale margin for eight large-cap banks covered by his firm expanded to 3.16% in 2012 from 1.94% in 2011. Usdin also estimated that the median gain-on-sale margin would decline to 2.75% in 2013 and 2.33% in 2014. These combined figures exclude Regions Financial of Birmingham, Ala., because "it does not offer the same granularity" as other large-cap regional banks covered by Jefferies, according to Usdin.

Jefferies also said mortgage production revenue for the group of eight large-cap banks more than doubled in 2012. The firm estimates that their mortgage production revenue will decline by 19% during 2013 and by another 24% in 2014.

Usdin says Wells Fargo ( WFC) will take the biggest hit on gain-on-sale margins during 2013, with the margin declining by 43 basis points to 1.92%, dropping further to 1.55% in 2014. Jefferies also estimates that Wells Fargo's mortgage production revenue will decline to $8.79 billion in 2013 from $12.2 billion. For 2013, Usdin estimates Wells Fargo's mortgage production revenue will total $6.63 billion.

Usdin rates Wells Fargo "buy," with a $39 price target, estimating the company will earn $3.55 a share this year, with EPS increasing to $3.65 in 2014.

A Downgrade for SunTrust

Usdin on Friday downgraded SunTrust ( STI) of Atlanta to "hold" from "buy," while lowering his price target for the shares to $30 from $32. "We are more concerned about the revenue transition gap that could emerge with the likely refi slowdown and gain-on-sale margin normalization."

Jefferies estimates that SunTrust's mortgage gain-on-sale margin will decline to 2.86% in 2013 from 3.29% in 2012, with the margin declining further to 2.61% in 2014. The firm also estimates that the bank's mortgage production revenue will decline to $828 million this year from $1.056 billion in 2012, declining further to $679 million in 2014.

Usdin estimates the company will earn $2.70 a share this year, with 2014 EPS of $2.85.

Taking It a Step Further

Jefferies conducted a "static test," which Usdin described as a "'what if?' scenario in which gain-on-sale margins reverted to 2011 levels overnight." The analyst said "banks in our stress test could see 5% negative EPS revisions for 2013 and 3% revisions in 2014 vs. our published EPS estimates."

SunTrust, along with BB&T ( BBT) of Winston-Salem, N.C., and Fifth Third Bancorp ( FITB) of Cincinnati "screen the worst in our simple exercise, relatively speaking, given the size of their underlying mortgage businesses and above-average gain-on-sale margin expansion seen over the last year, Usdin said.

Under the "2011" scenario, SunTrust's 2013 EPS estimate would decline by $0.27 and his 2014 estimate would decline by $0.16.

For BB&T, Jefferies estimates earnings of $3.05 a share for both 2013 and 2014. Under the scenario of mortgage gain-on-sale margins reverting to 2011 levels, Usdin estimates that the company's earnings would decline by 23 cents for 2013 and 14 cents for 2014.

Usdin estimates that Fifth Third will earn $1.65 a share this year and in 2014. If gains-on-sale margins declined to 2011 levels, the analyst estimates the company's earnings would be lowered by $0.12 for 2013 and $0.07 for 2014.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

The new credit rating at Wells Fargo is still in the upper tier on S&P's scale of investment-grade bond issuers, so the cut may have little immediate impact. But it's a sign that the scandal is taking an incremental toll on the bank's creditworthiness and could push up its borrowing costs slightly.

Wells Fargo, the embattled U.S. bank, plans to "refresh" its board to improve oversight of management. But corporate-governance experts say the term has become a euphemism for the delicate art of shaking up a failed board without blaming individual directors.